Big Banks Systematically Hiding Potential Losses: Report

In this Wednesday, Dec. 19, 2012 photo, a man walks past a Wells Fargo location in Philadelphia. U.S. banks are closing the year with the strongest profits since 2006 and fewer failures than at any time since the financial crisis struck in 2008. They're helping support an economy slowed by high unemployment, flat pay, sluggish manufacturing and anxious consumers. (AP Photo/Matt Rourke)

If you think the big banks learned painful lessons about risk-taking during the financial crisis, think again: They're still taking the same risks, and we don't even know how big those risks are.

In the latest edition of The Atlantic, Frank Partnoy and Jesse Eisinger have a 9400-word opus on the untold horrors lurking on big-bank balance sheets. The elevator summary: Boy, banks sure do a lot of dodgy trading, and they hide their potential losses from investors.

This may not come as shocking news. But it's one of those things that we can't hear often enough, with the momentum for reform cooling every day we get further away from the crisis. Big banks still have the capacity to blow up the financial system, and our inability to trust them makes another disaster even more likely.

Particularly useful is Partnoy and Eisinger's deep dive into the latest annual report of a supposedly staid, conservative bank, Wells Fargo. The authors discover that the bank is not simply lending money and giving away toasters, like banks used to do. Based on the authors' accounting, it looks like nearly $20 billion of Wells Fargo's $81 billion in revenue in 2011 came from one kind of trading or another.

And the bank doesn't offer much, if any, detail about the potential risks of that trading. How much money could Wells Fargo lose on its trades, which include hard-to-trade and hard-to-value derivatives? In the worst case, could the losses threaten the $148 billion in capital reserves Wells Fargo claims to have? Nobody knows, because Wells Fargo doesn't tell us, and they're not required to.

Meanwhile, even more risk is being shoved under the carpet, into entities that don't show up on bank balance sheets, but for which the banks are nevertheless ultimately on the hook. These are the sorts of accounting tricks used by Enron and by the banks before the crisis, and they're still in use.

And this is just Wells Fargo, which is supposedly one of the less-risky banks. The story also mentions JPMorgan Chase, which until early last year was considered a bedrock of solid risk-management, until its chief investment office blew $6 billion (and counting) on risky derivatives bets.

Though JPMorgan's losses barely made a dent in the bank's profits and only temporarily hit its stock price, the debacle did longer-term damage to investor trust in the banks, which was already shaky anyway. That lack of trust makes it harder for the banks to raise capital and more likely that investors will turn on them during a crisis.

It's understandable that the banks want to take on risks. In a sluggish economy without much need for borrowing, and with regulators breathing down their necks to hold more capital, banks are having a harder time turning a profit. Spinning the roulette wheel or buying a bunch of credit default swaps can help deepen the bonus pool.

But not always. In fact, banks are helplessly terrible at trading, according to a recent study by economists Arnoud Boot at the University of Amsterdam and Lev Ratnovski at the International Monetary Fund. Their report declared that "crises associated with trading by banks are bound to recur" and called for restrictions on bank trading.

The Volcker Rule of the Dodd-Frank financial-reform law was supposed to accomplish that, but it has been lobbied into near-uselessness. Partnoy and Eisinger call for a clean restriction on bank trading, as well as clear requirements that banks disclose more of their risks, in ways we can all understand. These seem like reasonable goals. Unfortunately, they'll probably never happen. But at least we shouldn't be surprised when the next blowup occurs.

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